Why Argentina's Financial Crisis Matters

The world is not ready for another financial crisis, but another financial crisis may be ready for the world.

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OK, the odds of this are long. Still, they're not nonexistent. The history of modern financial crises is that, originating in obscure corners of the financial system, they are initially ignored because they seem innocuous -- and then wham!

Think Thailand in 1997; a run against the Thai baht ultimately led to crises in South Korea, Indonesia, Russia and Brazil. Or consider U.S. "subprime" mortgages; in 2008, they triggered a collapse of global credit markets. Or recall Greece in 2010; its debt threatened the very existence of the euro.

The action these days involves Argentina. It has suffered a sudden loss of confidence. Since mid-April, its currency, the peso, has lost about 12% of its value against the dollar. To stem the panic -- that is, to convince investors not to sell pesos for dollars -- Argentina's central bank has raised interest rates on pesos from 27.25% to 40%.

No dice. These measures haven't fully stabilized financial markets. Argentina's latest move is to apply to the International Monetary Fund -- a global agency that makes loans to financially frail countries -- for a reported $30 billion bailout. The apparent aim is to instill confidence by demonstrating that the country has ample dollar reserves to meet maturing debts.

The crucial question is whether all this is just an Argentina problem -- or a harbinger of a broader financial crackup.

For the moment, it's mostly an Argentina issue, says economist Monica de Bolle of the Peterson Institute for International Economics.

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The present president, Mauricio Macri, who took office in late 2015, inherited a doleful legacy of economic mismanagement: high inflation, unemployment and budget deficits after 12 years of leftish economic policies.

Referring to Macri's predecessor, Cristina Kirchner, de Bolle says: "She just blew up the economy" with subsidies, price controls and easy money. Argentina couldn't borrow dollars in international markets, because it had defaulted on its government debt in 2001 and was locked in a bitter legal struggle with its creditors. It was hard to know the economy's precise condition, because the government stopped publishing many statistics. As best can be determined, inflation peaked at about 40% annually, de Bolle says.

Macri reversed many of these policies. He settled with the creditors and reduced budget deficits and inflation. "There was a sense of optimism ... that things were moving in the right direction," she says. But the pace has been deliberately "gradualist," leaving the economy vulnerable to adverse developments. According to de Bolle, the budget deficit is still about 5% of the economy (gross domestic product), as is the current account; inflation is about 25%. (For comparison: The US budget deficit is now approaching 5% of GDP.)

Perhaps inevitably, adverse developments have now arrived. American interest rates have edged up, reducing the attractiveness of Argentine debt; President Trump's trade policies threaten Argentina's exports; and the dollar has appreciated, making it costlier to repay dollar debts. It's harder for Argentina's economy to grow, leading anxious investors to dump pesos.

What is to be feared is the possibility that what's happening to Argentina could happen to other nations. For the last two years or so, international investors have poured money into "emerging market" countries, such as Argentina, Brazil, Mexico, India, China and Indonesia. In 2017, inflows to 25 of these countries totaled $1.2 trillion, according to the Institute of International Finance, a research and advocacy group for global financial institutions.

If these inflows slowed significantly -- or stopped altogether -- there would be negative consequences for the wider world economy. Countries might have to raise interest rates to defend their currencies against crippling depreciations. At some point, herd behavior might take over: Investors would buy or sell financial instruments (stocks, bonds, currencies and the like), mainly because they thought that others were going to buy or sell the same instruments.

What seems especially worrisome, argues economist Desmond Lachman of the American Enterprise Institute, is the "abrupt change in market sentiment." Investors who only recently had been emerging-market enthusiasts have suddenly become risk-averse skeptics. We may or may not be on the edge of another financial crisis, but regardless of what you think, there's plenty of room for self-doubt. One way or another, Argentina matters.

Samuelson has written about business and economic issues for the Washington Post since 1977.

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